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The Price Mechanism and the Invisible Hand 3

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The Price Mechanism and the Invisible Hand 3 Exclusive Hyun Kim Jung Hoon Hong Daiki Kim Meejoo Song Wooseung Sohn 1 I. INTRODUCTION In our presentation, there are four main subjects that we will be explaining today. Those subjects are: 1. Private goods and the Free Market System. 2.The Price Mechanism and the Invisible Hand 3. Public goods and the market failure 4. Public hand and the government failure. Before we go into the details, let me briefly give you the overview. First we have to approach these questions by asking ourselves… What do we mean by Exclusive? Of course, the word exclusive can be heard on a regular basis. For example, an exclusive interview with Professor Kim. Then what does the word exclusive mean? According to the dictionary, the word “exclusive” is defined as “not divided or shared with others” So how is this relevant to what we are studying? How is it connected to the rights? You might ask… There were discussions as to what “exclusiveness” meant. In my perspective, there are spiritual and material interests that are protected by the laws. Since, these interests are protected, as the characteristic of the rights, the interest become exclusive when it becomes a right. In having an exclusive right would mean that a person could enjoy the right at his or her wish. Therefore, we felt that there was a close link to the free market system and the right. Well, let’s go back to the last week’s lecture. If you can remember, Sun-young gave us a splendid presentation on the bourgeoisie last week. Then the professor explained to us that the reason that we did not have a revolution of the middle class in Korea was because there was not a combined force of wealth and integrity. And if you could remember, he also told us that in a situation where a relationship of wealth and integrity is cordial, it meant a formation of a democratic society. Whereas a situation where the relationship of wealth and integrity is dominated by the integrity, it meant a communistic society. Now as Hyun will explain in a minute that a political form of government may or may not have to do with the economic form of the government. However, historically speaking, the countries that formed a democratic society tended to go along with the free market system of economy whereas the countries that formed a communist society 2 tended to go along with the controlled market system. Also, I would like to point out… or rather question the professor whether the chart that he explained this… showed the relevance of what I have just said. It seems to me that a situation where the integrity has the power over the wealth has to do with the control… over the wealth and therefore, making this a controlled market system. For the free market system, the relationship between the integrity and the wealth is cordial… and therefore, there is a room for the free market system. In other words, the word “exclusive” used in Weber’s definition deals with the balance between free market system and the controlled market system Okay. By now, you should be asking another question. “Then why are we approaching this question from an economic standpoint?” Well, I can answer that question. The reason is because from the professor’s chart, we are dealing with only wealth for this case. The integrity is something that is not only intangible but also is unlimited. However, wealth… there are only limited resources, and therefore an absolute exclusive right regarding wealth is probably impossible to begin with… Approaching from the historical perspective, this is also true in the sense that there is a shift from Adam Smith’s Lasseiz Faire economic principle where there was absolute freedom in economy, to the economic principle where there is a government intervention. Now, I will turn this over to Hyun for his part of this presentation on Free Market System. II. FREE MARKET SYSTEM 1) Democracy and Free Market System The relationship between democracy and Free-market system is one of the most important political questions. Historically, we saw many collapses of democracy caused by crisis of economical situation. However, still there is no exact concept about the relationship. Just there are many theories. -Direct interrelation -Democracy will be bad or good influence on economic system (one-sided influence) -Political or econo-sociological view 2) Principles of Free Market System - Private Interest and Functions of Market ①Basic Principles : Private Ownership in Property, Private planning for a profit, Guarantee about freedom to economic determinism 3 → Free Market System(the Denial to interference of Government) ② Free Competition : the principle of scarcity, → realization of free competition through private planning for a profit abundances in whole society ③ the Functions of Market : Decision about the kinds and amounts of goods needed in society, motivating efficient production → Efficient distribution in resource, abundant life, Increasing social power for supply III. THE PRICE MECHANISM - THE INVISIBLE HAND THE INVISIBLE HAND “The invisible hand’ was a metaphor used by Adam Smith to describe the principle by which a beneficent social order emerged as the unintended consequences of individual actions. It was the notion of the invisible hand that enabled Smith to develop the first comprehensive theory of the economy as an interrelated social system. In general, the concept is composed of three logical steps. The first is the observation that human action often leads to consequences that were unintended and unforeseen by the actors. The second step is the argument that the sum of these unintended consequences over a large number of individuals or over a long period of time may, given the right circumstances, result in an order that is understandable to the human mind and appears as if it were the product of some intelligent planner. The third and final step is the judgement that the overall order is beneficial to the participants in the order in ways that they did not intend but nevertheless find desirable. In Smith’s economic theory described in the Wealth of Nations, money, prices and profit and loss provide the signals that lead to corrections in resource misallocation and to economic growth, while the economic institutions of markets, money and division of labor all emerged in an evolutionary process. The notion of spontaneous order in the sense of a self-ordering system continued to provide the foundation of economic science and especially general equilibrium theory throughout the 19th century and up to the present. The invisible hand still makes the system run, but the optimality of the result is not always generally guaranteed. PRICE MECHANISM The price mechanism is a system of determination of prices and resource allocation. It operates in a free market situation where forces of demand and supply dictate prices. It is the process by which changes in prices guide and shape changes in 4 the value and types of the goods and services that are produced. The price mechanism will determine: “WHAT IS PRODUCED, HOW MUCH IS PRODUCED AND FOR WHOM A GOOD OR SERVICE IS PRODUCED FOR.” The Law of Supply and Demand The prime movers in our model market are the forces of supply and demand. They determine the price of the good and the quantity exchanged in any given market. The shoe market is an example of a competitive market where a number of firms compete to meet the demand for certain products or services. Two kinds of participants operate in it: those who have money and want shoes (demanders) and those with shoes who want money (suppliers). For the demanders of shoes there is an inverse relationship between the price of shoes and the quantity demanded. Such a relationship is described by curve DD in Figure 1-1. This curve is a market demand curve and, as such, it incorporates the individual demands of all the households. Its negative slope reflects the Law of Downward Sloping Demand. Figure 1-1 For suppliers of shoes the relationship is somewhat different. Because of the Law of Diminishing Marginal Returns, a higher price induces a greater output than does a lower price. Consequently, a direct relationship exists between the price of shoes and the quantity that potential sellers are willing to supply to the market. (Refer to Figure 1- 1) In representing the forces of supply and demand as a supply curve (SS) and a 5 demand curve (DD), the quantities demanded and supplied are pictured as being dependent only on the price of the commodity. However, many other factors are hidden in such a simplification. The ceteris paribus assumption applies in drawing the demand curve1 and the supply curve.2 If any one of these variables should change, the demand curve and the supply curve for shoes would be altered. The demand and supply curves are tools necessary for us to discover how prices and quantities in any given market are determined. Competitive Bidding and Equilibrium Both producers and consumers base their respective production and consumption plans on the prevailing market price. When consumers pay a price for a commodity, they motivate the producer of that commodity and hence more of the same is produced and vice versa. The price paid becomes a vote for more production. Thus resources are channeled there. Suppose consumers decide that they want to spend more on shoes. More consumers show up at stores hoping to buy shoes. The stores see the higher demand, raise their prices, and also order more shoes from producers. Higher profits from making shoes induce firms to expand production. Higher prices for shoes curb demand.
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